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Use your illusion

  • We see downside risk to 4Q21F consensus net profit based on our view of banks’ preference for stable profits, proxied via a 2-year CAGR.
  • While 9M21 net profit growth of the China banks rose 12.5% yoy, this strong growth is transitory and is driven by a low base, with 2-year CAGR at 0%.
  • Base effects get tougher in 4Q21F, as 4Q20’s net profits rose 47% yoy. If 2- year CAGR remains constant, this implies FY21F profit growth of 8% yoy.
  • Downgrade sector to Neutral. We prefer banks with a rebounding ROE; our top picks remain CMB, PAB, CITIC and CCB in that order.
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Consensus 4Q21F earnings look high in our view

We see downside risks to Wind consensus 4Q21F net profits averaging 8% for big four banks, with BOC (-17%) and ICBC (-10%) most adversely impacted (Fig 1). This is based on our premise that big state-owned banks prioritise stability of net profits, and that a 2- year compounded annual growth rate (CAGR) methodology for FY19-FY21F can be an accurate way to estimate FY21F net profits and thus adjust for low FY20 base effects.

Looked like strong growth, but beware the low base

Banks’ 3Q21 net profit rose 14% yoy, with 9M21 net profit growth also strong at 12% yoy. While 9M21 net profit yoy growth is the strongest since 9M13, we point that this is not due to strong underlying growth but rather driven by a low base, given that 9M20 net profit fell 11% yoy. 9M21’s 2-year CAGR net profit was actually flat (Fig 6).

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This should show in 4Q21F’s growth, given tougher base effects

Base effects get tougher for 4Q21F’s net profit growth, as 4Q20’s net profits rose 47% yoy. Using FY17-FY19’s 2-year CAGR as a proxy and assuming it remains constant over FY19-FY21F, we calculate this implies FY21F profit growth of 8% yoy on average for the banks under our coverage and 6% yoy for China’s big four banks. This implies a 1.5%-pt downside risk to big four banks’ FY21F net profits (or 7.5% to 4Q21F net profits).

Elevated investor concerns over asset quality & policy risks

We think rising asset quality pressures are manageable from an EPS point of view, given sizable provisioning buffers and conservative non-performing loan (NPL) recognition ratios. Nevertheless, banks’ share prices could struggle to perform as we think both property sector stress and macroeconomic indicators are not likely to materially improve over the next few months. This could see investor concerns over asset quality and policy risks such as ‘surrendering’ profits (see Between a rock and a hard place dated 18 Jun 2020), remain elevated, and thus make it difficult for these banks to re-rate.

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Downgrade to sector Neutral; Prefer banks with rebounding ROE

We downgrade the China banks sector to Neutral from Overweight. We value the China banks using a stress test adjusted GGM. Top picks remain CMB, PAB, CITIC and CCB in that order as we see more potential for their higher FY21F ROEs to drive a P/BV rerating. We downgrade ICBC-A, CCB-A, BOC-A, ABC-A, BOCOM-A, BOCOM-H to Hold from Add, and CQRCB-A to Reduce from Hold. Upside/downside risks are a better/worse economy, and higher/lower interest rates.